Sefton Council has approved plans from the Homes & Communities Agency for 370 homes on a 35-acre site in Maghull.
The scheme includes affordable housing, a new railway station to access the development, motorway junction improvements and associated landscaping.
The HCA submitted an outline planning application to Sefton Council in May after a public consultation phase.
The former hospital site was acquired by the HCA from the Ministry of Justice in 2013 as part of the government's accelerated land disposal programme after plans to build a new prison on the site fell through.
The HCA said the masterplan for the site "will create an attractive network of open spaces".
Richard Jones, HCA area manager, said: "The HCA acquired this site as part of the government's initiative to accelerate the delivery of much needed housing on sites within the public sector portfolio, so I'm pleased that we have been able to secure a resolution to grant planning permission at this time. The whole team worked hard to ensure the application addressed the concerns and expectations of the local community."
The HCA is now seeking a development partner to bring forward the project. Construction is scheduled to begin in autumn 2015.